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20 March 2021

An Open Letter to the Chancellor of the Exchequer (2)

Tag(s): Politics & Economics, Business, Current Affairs
Dear Mr Sunak,

You said in your budget two weeks ago that you wanted to be honest with the British people and help them understand the state of the public finances. In this letter I wish to explain how I think you have been less than honest with the British people around a number of factors in terms of the state of the public finances.

Your budget appears to have been well received by the majority of the British people and in opinion polls the Conservative party is doing very much better than it has for some time. No doubt you can take credit for much of this. There is no question that you have had a very difficult first year as Chancellor of Exchequer, perhaps more difficult than for any Chancellor in recent memory. You have been applauded for the actions you have taken particularly in areas like furloughing and no doubt this explains part of your popularity. In this budget you have taken a number of actions, that I think are designed to show that you are serious about reducing the level of debt over the course of the rest of this parliament.

However, the level of investment in the UK is the worst in the G-7. I believe that few of your actions will do anything to address this. If the investment is to come from overseas, we have to earn that through a competitive, low and stable tax regime. The burden of tax was already at its highest level since Clement Attlee was Prime Minister even before the epidemic and is now going to go higher still. The Conservative party’s move to the left may be temporarily electrically successful as polling suggests but in the longer-term high taxes do not work and they depress living standards. This experiment is bound to end in catastrophe. The Taxpayers’ Alliance reported before your budget that in the 10 years since the Conservative party came to power there have been 1,034 increases in tax, a shameful record.

24 OECD countries have a net lower effective marginal rate of tax than the UK. Corporation tax increases are always felt by employees and customers because the cost is passed on in reduced productivity, higher prices and lower wages.

You are right that over time the deficit must not be too big, but the answer is lower spending and faster growth, not an ever higher, Eurozone – style tax burden. Covid-19 leaves the UK with debt levels not seen since the 1960s and you had the double whammy of reduced tax income through lower levels of business and employment, and increased spending. I wrote a similar open letter to then Chancellor of the Exchequer, Philip Hammond, in 2018 at the time when the national debt was set to rise in his budget to 80% of GDP. Your budget is going to see the national debt increased to 105% of GDP and that is based on some assertions in your budget that I think are unlikely to happen.

For example, the extra costs to the NHS of dealing with the vaccination programme are likely to go on in future years as we learn to live with this new virus just as we live with seasonal influenza. I am sure that when you started the furlough scheme you had no intention or indeed idea that it would continue for the best part of the year. In January, some 4.7 million people were on your furlough scheme and some business sources estimate that one third of these will lose their jobs on a permanent basis meaning that the current level of 5% unemployment is likely to double to 10% of the workforce.

You have also extended the self-employment relief schemes, VAT cuts, stamp-duty holidays, business rates relief, universal credit top ups and various other measures all of which have added another £65 billion spending for the 2021-2022 tax year that leaves us with overall borrowing for 2021-2022 at an estimated £234 billion, according to the Office for Budget Responsibility (OBR), very different from the £164 billion forecast in November. You were stuck with a manifesto commitment not to increase the rates of income tax, VAT and National Insurance, the three largest sources of income for the Treasury. So instead of increasing the rates you have increased the amount that you will receive from income tax by using fiscal drag which means that a very large number of people will actually pay more income tax. When I met Philip Hammond when he was Chancellor of the Exchequer, I asked him how he could justify the marginal rate of income tax and national insurance of 62% that hit people on incomes over £100,000. His answer was that if we wanted public services then we had to pay for them. My financial adviser tells me that some of his clients, for example, surgeons turn away work that will put them into this tax bracket. It will also catch other public servants like head teachers.

But the biggest concern I have about your budget is that you have consciously moved away from a long-term policy of your party to have competitive rates of corporation tax. At the current rate of 18% it is a good bit lower than most other big economies. You plan to raise it to 25% and I cannot think of a single businessman I know who believes that you will earn as much from this move as your budget plans. One of the big advantages of Brexit we have been told is that we can do our own deals with other countries and I share that view, but another advantage should be that we would attract more inward investment and I am afraid that with some of the disadvantages of Brexit, and now this new level of corporation tax, that is going to be very hard to achieve.

Another move that I think is not well thought through is yet another taxpayer-sponsored support scheme for those who cannot produce enough for a house deposit to secure a mortgage. This will help the banks who effectively get a free money scheme (the most they can lose on any one deal is 5%) and the share prices of the big builders all went up because the one certain result of your move is that it will push prices up again. And it may well be when interest rates do move up as they must do in the mid-term, we may yet again have another generation in negative equity should house prices revert to the mean relative to earnings.

I was also concerned that yet again the thresholds for capital gains tax, inheritance tax and the pensions lifetime allowance are all to be frozen. Anyone planning for retirement has been faced with no fewer than five different policy approaches on lifetime tax relief limits since the system was introduced in 2006. Rather than provide a stable long-term framework for savers, the Treasury seems to regard pension tax relief as a tap that it can turn on when it is short of cash. If we want to nurture a long-term savings culture in the UK, this has to stop. As for Capital Gains Tax no consideration is given to how long you have owned an asset when you sell it, and hence how much its rising value is real and how much is just generalised inflation. That can make CGT more of a tax on wealth than on gains.

The same is true of inheritance tax which is probably the most unfair and unpopular tax of all. When it was originally introduced it was intended as a tax on the very wealthy. Now many of those who inherit their parents’ house will have to sell it to pay the inheritance tax that is due simply because of the rising value of houses. Inheritance tax is payable to HMRC immediately on probate, but it can take many months to sell a house.

You have defended your plans to raise corporation tax to 25%, just shy of what Jeremy Corbyn proposed at the last election, by suggesting that improved business tax receipts in recent years were not related to Tory governments’ cuts to the rate. You have tried to soften the blow by allowing companies super deductions at 130% on investments in the next two years but this is temporary while the corporation tax increase is permanent. At the very least your plan will lead to distortion in short-term investments. Long-term investments take time to plan and implement so it is unlikely that there will be much change. However, companies like Amazon will relish the fact that they will not be paying any tax at all in the near future as they can make “investments” to offset the tiny amount of tax that they do pay.

The Centre for Policy Studies, a centre-right think tank, said that the plan would give the UK one of the least competitive tax systems of the 37 leading economies that are members of the Organisation for Economic Cooperation and Development and would have a chilling effect on investment and growth. The Institute for Fiscal Studies said there is a lot of uncertainty and they suspect you will get less than the £17 billion forecast in 2025-26.

I am unsure to what extent the introduction of freeports will make much difference as they will be areas outside UK customs territory, but still under central government control, and so freeports are likely to displace economic activity from one part of the country to another. It therefore seems that this decision is much more likely to have been introduced for political reasons rather than economic ones.

The problems in the UK economy are long-term and there seems no strategy in your proposals or those of your recent predecessors to address this. On OBR forecasts, even after the post-Covid economic bounce is finished, the long-term growth rate will still be a mere 1.7% as it has been more or less for the last 10 years. This is on gross measurement but if we look at the GDP per capita rate of growth it was on average 1.1% a year between 2010 and 2019 compared with 2.4% in the decade before the financial crisis, 1998 to 2007. Linked to this is feeble productivity growth. Since 2010, output per hour has gone up only an average of 0.4%, compared with 2.6% in the 1990s.

To address this, we need to see less government not more, less taxation not more, but we do need to see investment in education and innovation. One of your better predecessors, Nigel Lawson made a point of getting rid of a tax in each of his budgets with a long-term strategy of simplifying the tax code. Unfortunately, the measures conducted by your recent predecessors, and now you, are complicating an already highly complicated tax code. One tax that you could have got rid of would be stamp duty instead of just your short-term stamp duty holiday on houses costing less than £600,000.

The new tax that we do need to see is a tax on carbon. If we are realistic about the carbon zero targets that the government has set, and these targets are now in law, then we cannot continue to have contradictory policies like not increasing tax on fuel. And finally, I was hoping that you would explain what is happening to monetary policy. The Bank of England will soon own one half of your government’s outstanding gilt stock. The Bank of England balance sheet has doubled under lockdown expanding by £450 billion. The Bank of England additional quantitative easing almost exactly matches your government borrowing since March 2020. We are told that the Bank of England is independent but month by month it has issued cash which almost precisely matches your borrowings. This is untenable and will lead to a dismal financial catastrophe unless plenty of action is taken.

Yours sincerely, Dr David Pearson

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